Liquidity and Capital Resources

Our cash requirements are primarily for working capital, construction of new stores, remodeling of existing stores and improvements to our information systems. Historically, we have met these cash requirements from cash flow from operations, short-term trade credit and borrowings under our revolving lines of credit, long-term debt and capital leases.

Discussion of Cash Flows

For the 39-week period ended October 30, 2004, cash and cash equivalents decreased by $7.8 million to $2.2 million from $10.0 million at the end of fiscal 2003. The primary contributor to the decrease in cash and cash equivalents was $6.2 million of cash used in investing activities, primarily for new stores, and $5.3 million of cash used in operating activities, primarily an increase in inventory levels, partially offset by $3.8 million of cash from financing activities, primarily borrowings under our revolving lines of credit.

For fiscal 2003, cash and cash equivalents increased by $4.2 million to $10.0 million from $5.8 million at the end of fiscal 2002. The primary contributor to the increase in cash and cash equivalents was $11.3 million of cash provided by operations, partially offset by $6.2 million used in investing activities, primarily to construct new stores. For fiscal 2002, cash and cash equivalents increased by $1.7 million to $5.8 million from $4.1 million at the end of fiscal 2001. The primary contributor to the increase in cash and cash equivalents was $10.5 million of cash provided by operations, partially offset by $5.9 million used in investing activities, primarily to construct new stores and $2.8 million from cash used in financing activities, primarily to pay down our revolving lines of credit.

Net cash provided by operating activities decreased in the 39-week period ended October 30, 2004 compared to the 39-week period ended November 1, 2003 primarily because of increased investments in inventory totaling $14.7 million compared to $10.8 million in the prior 39-week period. This change related to the timing of the flow of goods for the Christmas season and the funding of 35 new store inventories in the fiscal 2004 period

compared to 22 in the prior period. Net cash provided by operating activities was $11.3 million for fiscal 2003 and $10.5 million for fiscal 2002. Net cash provided by operating activities increased in fiscal 2003 compared to fiscal 2002 primarily because net income increased. Net cash provided by (used in) operating activities was $(5.3) million for the 39-week period ended October 30, 2004 and approximately $(84,000) for the 39-week period ended November 1, 2003.

Net cash used in investing activities was $6.2 million for the 39-week period ended October 30, 2004 and $5.1 million for the 39-week period ended November 1, 2003. Net cash used in investing activities increased in the 39-week period ended October 30, 2004 compared to the 39-week period ended November 1, 2003 because we purchased additional property and equipment to open 35 new stores compared to 22 new stores in the prior period. Net cash used in investing activities was $6.2 million for fiscal 2003 and $5.9 million for fiscal 2002. Net cash used in investing activities increased in fiscal 2003 compared to fiscal 2002 because we purchased additional property and equipment to open 25 new stores compared to 16 new stores in the prior year.

We anticipate that our capital expenditures will increase to approximately $10 million in fiscal 2005 and $26 million in fiscal 2006. Fiscal 2005 spending relates to the purchase of property and equipment for the 40 stores we plan to open in 2005. The increase in fiscal 2006 relates to the planned purchase or construction of a new distribution center and the purchase of property and equipment for the 40 stores we plan to open in fiscal 2006. We plan to finance these capital expenditures over the next two fiscal years with cash flow from operations and a portion of the net proceeds from this offering.

Net cash provided by financing activities was $3.8 million for the 39-week period ended October 30, 2004 and $2.3 million for the 39-week period ended November 1, 2003. Net cash provided by financing activities for the 39-week period ended October 30, 2004 was primarily attributable to borrowings of $5.4 million on our secured line of credit, partially offset by $1.0 million in preferred stock dividend payments and approximately $623,000 in capital lease and mortgage payments. Net cash provided by financing activities for the 39-week period ended November 1, 2003 was primarily attributable to borrowings on our secured line of credit. Net cash used in financing activities was approximately $942,000 for fiscal 2003 and $2.8 million for fiscal 2002. Net cash used in financing activities for fiscal 2003 was attributable to payments on capital lease obligations and mortgage payments on our Fahm Street facility. Net cash used in financing activities for fiscal 2002 was primarily attributable to $3.7 million in repayments of our secured line of credit and approximately $742,000 in payments on capital lease obligations, partially offset by $1.7 million in proceeds from the mortgage on our Fahm Street facility. Until required for other purposes, we maintain our cash and cash equivalents in deposit accounts or highly liquid investments with remaining maturities of 90 days or less at the time of purchase.

Liquidity Sources, Requirements and Contractual Cash Requirements and Commitments

Our principal sources of liquidity will consist of: (i) cash and cash equivalents (which equaled $2.2 million as of October 30, 2004); (ii) a secured line of credit with a maximum available borrowing of $25.0 million subject to our inventory levels (with availability of $21.0 million and $4.0 million drawn down as of October 30, 2004); (iii) an unsecured line of credit with a maximum available borrowing of $3.0 million subject to our inventory levels (with availability of $1.6 million and $1.4 million drawn down as of October 30, 2004); (iv) cash generated from operations on an ongoing basis as we sell our merchandise inventory; (v) trade credit; and (vi) the remainder of the net proceeds from this offering after the redemption of our Series A Preferred Stock and the repayment of outstanding indebtedness. Short-term trade credit represents a significant source of financing for our inventory purchases. Trade credit arises from customary payment terms and trade practices with our vendors. Our management regularly reviews the adequacy of credit available to us from our vendors. Historically, our principal liquidity requirements have been to meet our working capital and capital expenditure needs.

We believe that our sources of liquidity will be sufficient to fund our operations and anticipated capital expenditures for at least the next 24 months. Our ability to fund these requirements and comply with the financial covenants under our secured lines of credit will depend on our cash flow, which in turn is subject to prevailing economic conditions and financial, business and other factors, some of which are beyond our control. In addition, as part of our strategy, we intend to continue to open new stores, which will require additional capital. We cannot assure you that additional capital or other sources of liquidity will be available on terms acceptable to us, or at all.

The following table discloses aggregate information about our contractual obligations as of October 30, 2004 and the periods in which payments are due:

Indebtedness.  We have a revolving line of credit secured by substantially all of our assets pursuant to which we pay customary fees. This secured line of credit expires in April 2007. This secured line of credit provides for aggregate cash borrowings and the issuance of letters of credit up to the lesser of $25.0 million or our borrowing base (which was approximately $24.0 million at October 30, 2004), with a letter of credit sub-limit of $2.0 million. Borrowings under this secured line of credit bear interest at the prime rate plus a spread or LIBOR plus a spread, at our election, based on conditions in the credit agreement. As of October 30, 2004, outstanding borrowings on the line of credit totaled $4.0 million at an interest rate of 4.75%, and there were no outstanding letters of credit as of that date. Under the terms of the credit agreement, we are required to maintain a minimum tangible net worth of $3.9 million.

In September 2003, we entered into an annual unsecured revolving line of credit with Bank of America that was renewed in June 2004. The line of credit provides for aggregate cash borrowings up to $3.0 million to be used for general operating purposes. Borrowings under the credit agreement bear interest at LIBOR plus a spread, and the interest rate was 3.96% as of October 30, 2004. At October 30, 2004, $1.4 million was outstanding under this revolving line of credit. We intend to pay down any outstanding balance on this unsecured line of credit with a portion of the net proceeds from this offering.

We borrow funds under these revolving lines of credit from time to time and subsequently repay such borrowings with available cash generated from operations.

Capital Leases.  We have capital lease obligations that financed the purchase of our computer equipment. At October 30, 2004, our capital lease obligations were $1.3 million. These obligations have maturity dates ranging from May 2004 to October 2007. The interest rates on these obligations range from 0.6% to 11.5%. All of these obligations are secured by the computer equipment.

Operating Leases.  We lease our stores under operating leases, which generally have an initial term of five years with one five-year renewal option. Some operating leases provide for fixed monthly rentals while others provide for rentals computed as a percentage of net sales. Some operating leases provide for a combination of both fixed monthly rental and rentals computed as a percentage of net sales. Rental expense was $6.4 million for fiscal 2003 and $4.8 million for fiscal 2002.

Purchase Obligations.  As of October 30, 2004, we had purchase obligations of $31.5 million, all of which were for less than one year. These purchase obligations primarily consist of outstanding merchandise orders.

Critical Accounting Policies

The preparation of our financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We believe the following critical accounting policies describe the more significant judgments and estimates used in the preparation of our financial statements:

     Revenue Recognition

Revenue from retail sales is recognized at the time of the sale, net of an allowance for estimated returns. Revenue from layaway sales is recognized when the customer has paid for and received the merchandise. If the merchandise is not fully paid for within 60 days, the customer is given a refund or store credit for merchandise payments made, less a re-stocking fee and a program service charge. Program service charges, which are non-refundable, are recognized in revenue when collected. All sales are from cash, check or major credit card company transactions. We do not offer company-sponsored customer credit accounts.

     Inventory

Inventory is stated at the lower of cost (first-in, first-out basis) or market as determined by the retail inventory method less a provision for inventory shrinkage. Under the retail inventory method, the cost value of inventory and gross margins are determined by calculating a cost-to-retail ratio and applying it to the retail value of inventory. We believe the first-in first-out retail inventory method results in an inventory valuation that is fairly stated.

     Property and Equipment, net

Property and equipment are stated at cost. Equipment under capital leases is stated at the present value of minimum lease payments. Depreciation and amortization are computed using the straight-line method over the lesser of the estimated useful lives (primarily three to five years for computer equipment and furniture, fixtures and equipment, five years for leasehold improvements, and 15 years for buildings) of the related assets or the relevant lease term, whichever is shorter.

     Goodwill

Goodwill represents the excess of the purchase price over the fair value of assets acquired. We adopted the provisions of SFAS No. 142, Goodwill and Other Intangible Assets , as of February 3, 2002. Pursuant to SFAS No. 142, goodwill acquired in a purchase business combination and determined to have an indefinite useful life is not amortized, but instead tested for impairment at least annually. We performed this analysis at the end of fiscal 2003 and no impairment was indicated.

     Impairment of Long-Lived Assets

If facts and circumstances indicate that a long-lived asset, including property and equipment, may be impaired, the carrying value is reviewed. If this review indicates that the carrying value of the asset will not be recovered as determined based on projected undiscounted cash flows related to the asset over its remaining life, the carrying value of the asset is reduced to its estimated fair value. Impairment losses in the future are dependent on a number of factors such as site selection and general economic trends, and thus could be significantly different from historical results. To the extent our estimates for net sales, gross profit and store expenses are not realized, future assessments of recoverability could result in impairment charges.

     Stock-Based Compensation

We apply the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees , and related interpretations including FASB interpretation (FIN) No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25 , to account for our fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current fair value of the underlying stock exceeds the exercise price. We recognize the fair value of stock rights granted to non-employees in the accompanying financial statements. SFAS No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123 , establishes accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As permitted by existing accounting standards, we have elected to continue to apply the intrinsic-value-based method of accounting described above, and we have adopted only the disclosure requirements of SFAS No. 123, as amended. Pro forma information regarding net income and net income per share is required in order to show our net income as if we had accounted for employee stock options under the fair value method of SFAS No. 123, Accounting for Stock-Based Compensation , as amended by SFAS No. 148, Accounting for Stock-Based Compensation— Transition Disclosure . This information is contained in notes 2 and 8 to our financial statements. The fair values of options and shares issued pursuant to our option plan at each grant date were estimated using the Black-Scholes option pricing model.

     Store Opening and Closing Costs

New and relocated store opening costs are charged directly to expense when incurred. When we decide to close or relocate a store, we record an expense for the present value of expected future rent payments net of sublease income in the period that a store closes or relocates.

     Accounting for Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

The above listing is not intended to be a comprehensive list of all our accounting policies. In many cases the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result.

Quantitative and Qualitative Disclosure about Market Risk

We are exposed to financial market risks related to changes in interest rates connected with our revolving lines of credit which bear interest at variable rates. We cannot predict market fluctuations in interest rates. As a result, future results may differ materially from estimated results due to adverse changes in interest rates or debt availability. A hypothetical 100 basis point increase in prevailing market interest rates would not have materially impacted our financial position, results of operations, cash flows for fiscal 2004. We do not engage in financial transactions for trading or speculative purposes, and we have not entered into any interest rate hedging contracts.

We source all of our product from apparel markets in the United States and, therefore, are not subject to fluctuations in foreign currency exchange rates. We have not entered into forward contracts to hedge against fluctuations in foreign currency prices.

If we were to begin sourcing product directly from overseas, our risk management policy would allow us to utilize foreign currency forward and option contracts to manage currency exposures. If we were to enter into hedging contracts, we anticipate that the contracts would have maturities of less than three months and would settle before

the end of each quarterly period. Additionally, we do not expect to enter into any hedging contracts for trading or speculative purposes.

We had cash and cash equivalents totaling $2.2 million at October 30, 2004. These amounts were maintained in deposit accounts or highly liquid investments with remaining maturities of 90 days or less at the time of purchase. Due to the short-term nature of these investments, we believe that we do not have material exposure to changes in the fair value of our investments as a result of changes in interest rates. Declines in interest rates, however, will reduce future investment income. We do not enter into investments for trading or speculative purposes.

Recently Issued Accounting Standards

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets . SFAS No. 153 amends APB Opinion No. 29, Accounting for Nonmonetary Transactions , which requires that exchanges of nonmonetary assets be measured based on the fair value of the assets exchanged, but which includes certain exceptions to that principle. SFAS No. 153 eliminates the exception from APB Opinion No. 29 for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have a commercial substance. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The adoption of SFAS No. 153 is not expected to have a material impact on our consolidated financial position or results of operations.

In December 2004, the FASB issued a revision to SFAS No. 123, Accounting for Stock-Based Compensation . SFAS No. 123R replaces SFAS No. 123 and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees , and establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions and is effective as of the beginning of the first reporting period that begins after June 15, 2005 for public entities that do not file as small business issuers. We have illustrated the effect on our earnings as if we had adopted the fair value method of accounting for stock-based compensation under SFAS No. 123. This information is contained in notes 2 and 8 to our financial statements. The fair values of options and shares issued pursuant to our option plan at each grant date were estimated using the Black-Scholes option pricing model. The fair value-based method of SFAS No. 123 is similar in most respects to the fair value-based method under SFAS No. 123R, although the election of certain methods within the applicable transition rules of SFAS No. 123R may affect the impact on our consolidated financial position or results of operations. Such impact, if any, on our consolidated financial position or results of operations has not been determined.

In December 2003, the FASB issued FIN 46R, Consolidation of Variable Interest Entities , which is an interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements . FIN 46R requires that if an entity has a controlling interest in a variable interest entity, the assets, liabilities and results of activities of the variable interest entity should be included in the consolidated financial statements of the entity. FIN 46R is effective immediately for all new variable interest entities created or acquired after December 31, 2003. The adoption of FIN 46R is not expected to have an impact on our consolidated financial position or results of operations.

Business

We are a rapidly growing, value-priced retailer of urban fashion apparel and accessories for the entire family. We offer quality, branded products from nationally recognized brands, as well as private label products and a limited assortment of home décor items. Our merchandise offerings are designed to appeal to the preferences of fashion conscious consumers, particularly African-Americans. We provide this offering at compelling values with nationally recognized branded merchandise offered at 20% to 60% discounts to department and specialty stores’ regular prices. Our stores average approximately 8,500 square feet of selling space and are typically located in neighborhood shopping centers that are convenient to low to moderate income customers. Originally our stores were located in the Southeast, and we have recently expanded into the Mid-Atlantic region and Texas. We currently operate 200 stores in both urban and rural markets in twelve states. In each of fiscal 2005 and fiscal 2006, we intend to open 40 new stores, approximately 70% of which are expected to be located in states that we currently serve.

Our predecessor was founded in 1946 and grew to become a chain of family apparel stores operating in the Southeast under the Allied Department Stores name. In 1999, our chain of stores was acquired by Hampshire Equity Partners, a private equity firm. Our management team has implemented several strategies designed to differentiate our stores, improve our operating and financial performance and position us for growth, including:

Industry

According to a nationally recognized firm that specializes in apparel research, retail sales of off-price apparel totaled $16.5 billion in the U.S. in 2004, up more than 15% from 2003. The popularity of this segment continues to grow, with off-price retailers accounting for 9.5% of overall retail apparel sales in the U.S. in 2004, versus 8.6% in 2003 and 8.2% in 2002.

The off-price apparel market is dominated by large format, national apparel companies, such as The TJX Companies, Burlington Coat Factory and Ross Stores. These retailers generally target more affluent consumers and seek to achieve high volumes by serving the fashion needs of a broad segment of the population. Mass merchants and general merchandise discount retailers, such as Wal-Mart Stores, Inc. and Kmart Corp., also offer apparel at reduced prices, but generally focus on basic apparel and are less fashion oriented. As a result, we believe there is significant demand for a value retailer that addresses the market of low to moderate income consumers generally and, particularly, African-American and other minority consumers who seek value-priced, urban fashion apparel and accessories. We believe this market benefits from several favorable characteristics, including:

Growing Market with Favorable Demographics.  Based on U.S. Census Bureau data, approximately 31% of the U.S. population was non-white in 2000 versus approximately 20% in 1980. This percentage is estimated to increase to approximately 35% by 2010. Within this market, African-Americans represented 12.7% of the population as of 2000, which is expected to increase to 13.1% in 2010.

Significant Spending on Apparel.  Minority consumers possess significant spending power. According to the Selig Center for Economic Growth at The University of Georgia, or the Selig Center, the combined U.S. buying power

of non-whites grew from $540.8 billion in 1990 to approximately $1.2 trillion in 2000. During that period, buying power for African-Americans grew from $318.3 billion to $584.9 billion and is estimated by the Selig Center to grow approximately 65% to $964.6 billion in 2009.

We believe our core customers are more fashion oriented, which results in a greater propensity to purchase apparel. According to the U.S. Department of Labor, African-Americans spend 4.7% of their annual income on apparel and related products and services, compared to 3.5% for the U.S. population as a whole.

Expansion of Urban Apparel Brands.  In recent years, a series of nationally recognized urban brands, often associated with hip-hop and rap musicians, has emerged and gained significant popularity. These brands offer distinctive, urban apparel designed to appeal to African-American consumers, as well as to the broader population. Sales from 13 national urban apparel brands tracked by a nationally recognized firm that specializes in apparel research totaled approximately $1.9 billion in 2004, an increase of approximately 46% from 2003.

Business Strengths

Our goal is to be the leading value-priced retailer of urban fashion apparel and accessories. We believe the following business strengths differentiate us from our competitors and are important to our success:

Focus on Urban Fashion Mix.  We focus our merchandise on urban fashions, which we believe appeals to our core customers. We do not attempt to dictate trends, but rather devote considerable effort to identifying emerging trends and ensuring that our apparel assortment is considered timely and fashionable in the urban market. Our merchandising staff tests new merchandise before reordering and actively manages the mix of brands and products in our stores to keep our offering fresh and minimize markdowns.

Superior Value Proposition.  As a value-priced retailer, we seek to offer first quality, fashionable merchandise at compelling prices. Our assortment includes nationally recognized brands offered at 20% to 60% discounts to department and specialty stores’ regular prices. We also offer products under our proprietary brands such as Citi Steps, Diva Blue and Urban Sophistication. These private labels enable us to expand product selection, offer fashion merchandise at lower prices and enhances our product offerings.

Merchandise Mix that Appeals to the Entire Family.  We merchandise our stores to create a destination environment capable of meeting the fashion needs of the entire value-conscious family. Each store offers a wide variety of products for men and women, as well as infants, toddlers, boys and girls. Our stores feature sportswear, dresses, plus-sized apparel, outerwear, footwear and accessories, as well as a limited assortment of home décor items. We believe that the breadth of our merchandise distinguishes our stores from many competitors that offer urban apparel primarily for women, and reduces our exposure to fashion trends and demand cycles in any single category.

Strong and Flexible Sourcing Relationships.  We maintain strong sourcing relationships with a large group of suppliers. We have purchased merchandise from more than 1,000 vendors in the past twelve months. Purchasing is controlled by our 20-member buying team located at our Savannah, Georgia headquarters and in New York, New York, and our buyers have an average of more than 20 years of retail experience. We purchase merchandise through planned programs with vendors at reduced prices and opportunistically through close-outs, with the majority of our merchandise purchased for the current season and a limited quantity held for sale in future seasons. To foster our vendor relationships, we pay vendors promptly and do not ask for typical retail concessions such as promotional and markdown allowances or delivery concessions such as drop shipments to stores.

Attractive Fashion Presentation and Store Environment.  We seek to provide a fashion-focused shopping environment that is similar to a specialty apparel retailer, rather than a typical off-price store. Products from nationally recognized brands are prominently displayed by brand, rather than by size, on dedicated, four-way fixtures featuring multiple sizes and styles. The remaining merchandise is arranged on hanging racks. All stores are carpeted and well-lit, with most featuring a sound system that plays urban adult and urban contemporary music throughout the store. Nearly all of our stores have either been opened or remodeled in the past six years.

Highly Profitable Store Model.  We operate a proven and efficient store model that delivers strong cash flow and store level return on investment. We locate stores in high traffic strip shopping centers that are convenient to low and moderate income neighborhoods. We generally utilize previously occupied store sites. This approach enables

us to generate substantial traffic at attractive rents. Similarly, our advertising expenses are low as we do not rely on promotion-driven sales but rather seek to build our reputation for value through everyday low prices. At the same time, our unit investment is limited, as we do not spend large sums on fixturing, leasehold improvements, equipment or other startup costs. As a result, our stores generate rapid payback of investments, typically within 12 to 14 months.

Growth Strategy

Our growth strategy is to open stores in new and existing markets, as well as to increase sales in existing stores. Adding stores in the markets we currently serve often enables us to benefit from enhanced name recognition and achieve advertising and operating synergies. In fiscal 2003 and fiscal 2004, we opened 25 and 40 stores, respectively, and entered the Houston, Norfolk, Baltimore and Washington, D.C. markets. Of the 25 stores opened in fiscal 2003, the average sales of the 23 stores open for the twelve months ended October 31, 2004 was $1.2 million.

In each of fiscal 2005 and fiscal 2006, we intend to open 40 new stores, approximately 70% of which we expect to locate in states we currently serve.

We intend to increase comparable store sales through merchandising enhancements and the expansion of adjacent product categories. We have recently added a dedicated buyer in home décor and upgraded our buying capabilities and focus within the intimate apparel category.

Store Operations

Store Format. Our existing 200 stores’ average selling space is approximately 8,500 square feet, which allows us space and flexibility to departmentalize our stores and provide directed traffic patterns. New stores added in fiscal 2004 averaged approximately 10,700 square feet, which is larger than the stores added in fiscal 2003 and significantly larger than our historical store base. As a result of these new stores, as well as due to the remodeling and expansion of existing stores in fiscal 2003, our average square footage of selling space per store has increased from approximately 7,500 at the end of fiscal 2002 to its current level.

We arrange our stores in a racetrack format with women’s sportswear, our most attractive and fashion current merchandise, in the center of each store, and complementary categories adjacent to those items. Men’s and boy’s apparel is displayed on one side of the store while dresses, footwear and accessories are displayed on the other side. Merchandise for infants, toddlers and girls is displayed along the back of the store. Impulse items, such as jewelry and sunglasses, are featured near the checkout area. Products from nationally recognized brands are prominently displayed on four way racks at the front of each department. The remaining merchandise is displayed on hanging racks and occasionally on table displays. Large hanging signs identify each category location. The unobstructed floor plan allows the customer to see virtually all of the different product areas from the store entrance and provides us the flexibility easily to expand and contract departments in response to consumer demand, seasonality and merchandise availability.

Virtually all of our inventory is displayed on the selling floor. Our prices are clearly marked and often have the comparative retail-selling price noted on the price tag.

Store Management.  Store operations are managed by our Vice President of Store Operations, three regional managers and 21 district managers, each of whom typically manages eight to ten stores. Our typical store is staffed with a store manager, two or three assistant managers and seven to eight part time sales associates, all of whom rotate work days on a shift basis. District managers and store managers participate in a bonus program based on achieving predetermined levels of sales and profits. The district managers also participate in bonus programs based on achieving targeted payroll costs. Our regional managers participate in a bonus program based on a rollup of the district managers’ bonuses. The assistant managers and sales associates are compensated on an hourly basis with incentives. Moreover, we recognize individual performance through internal promotions and provide extensive opportunities for advancement, particularly given our rapid growth.

We place significant emphasis on loss prevention in order to control inventory shrinkage. Our initiatives include electronic tags on all of our products, training and education of store personnel on loss prevention issues, digital video camera systems, alarm systems and motion detectors in the stores. We also capture extensive point-of-sale

data and maintain systems that monitor returns, voids and employee sales, and produce trend and exception reports to assist us in identifying shrinkage issues. We have a centralized loss prevention team that focuses exclusively on implementation of our initiatives and specifically on stores that have experienced above average levels of shrinkage.

Employee Training.  Our employees are critical to achieving our goals, and we strive to hire employees with high energy levels and motivation. We have well-established store operating policies and procedures and an extensive 90-day in-store training program for new store managers and assistant managers. Our sales associates also participate in a 30-day customer service and store procedures training program, which is designed to enable them to assist customers in a friendly, helpful manner.

Layaway Program.  We offer a layaway program that allows customers to purchase merchandise by initially paying a 20% deposit together with a $2.00 service charge. The customer then makes additional payments every two weeks and has 60 days within which to complete the purchase. If the purchase is not completed, the customer receives a merchandise credit for amounts paid less a re-stocking fee and the service charge. Sales under our layaway program accounted for approximately 13% of our total sales in fiscal 2003.

Store Economics.  We believe we benefit from attractive store-level economics. The average investment for the 41 stores we opened in fiscal 2002 and fiscal 2003, including leasehold improvements, equipment, cost of inventory to stock the store (net of accounts payable) and preopening store expenses, was approximately $240,000. These 41 stores generated average sales of $1.2 million and average store level cash flow (exclusive of pre-opening expense) of $240,000 during their first twelve months of operation. Our average investment for the 40 stores opened in fiscal 2004 was approximately $280,000. This investment represents an increase over prior years as the size of our stores has increased and, in some instances, we have paid for leasehold improvements that we expect to recover over time. We expect these stores to generate similar levels of return on investment.

Store Locations

As of January 29, 2005, we operated 200 stores located in twelve states. Our stores are primarily located in strip shopping centers and downtown business districts. We have no franchising relationships as all of our stores are company-operated. The table below sets forth the number of stores in each of these twelve states and the specific markets within each such state in which we operated at least two stores as of January 29, 2005:

Site Selection.  Cost-effective store locations are an important part of our profitability model. Accordingly, we look for second and third use store locations that offer attractive rents, but also meet our demographic and economic criteria.

In selecting a location, we target both urban and rural markets. Demographic criteria used in site selection include concentrations of our core consumers. In addition, we require convenient site accessibility, as well as strong co-tenants, such as food stores, dollar stores, rent-to-own stores and other apparel stores. We prepare detailed demographic studies and pro forma financial statements for each prospective store location. Our economic criteria for a site include specific store-level profitability and return on capital invested.

We have a dedicated real estate management team responsible for new store site selection. Our group has identified a significant number of target sites in existing strip shopping centers and off-mall locations with appropriate market characteristics in both new and existing markets. We opened a total of 65 new stores in fiscal 2003 and fiscal 2004. In each of fiscal 2005 and fiscal 2006, we intend to open an additional 40 stores. We expect to fund our store openings with a portion of the net proceeds from this offering and cash flow from operations.

Shortly after we sign a new store lease, our store construction department prepares the store by installing fixtures, signs, dressing rooms, checkout counters, cash register systems and other items. Once we take possession of a store site, we can open the store within approximately three to four weeks.

Product Merchandising and Pricing

Merchandising.  Our merchandising policy is to offer high quality, branded products at attractive prices for the entire value-conscious family. We seek to maintain a diverse assortment of first quality, in-season merchandise that appeals to the distinctive tastes and preferences of our core customers. Approximately 30% of our sales are typically represented by nationally recognized brands. We also offer a wide variety of products from less recognized brands that represent approximately 60% of sales. The remaining 10% of sales represent private label products under our proprietary brands such as Citi Steps, Diva Blue and Urban Sophistication. Our private label products enable us to expand product selection, offer merchandise at lower prices and enhances our product offerings.

Our merchandise includes apparel, accessories and home décor. Within apparel, we offer men’s, women’s, which includes dresses, sportswear and plus size offerings, and children’s, which includes offerings for infants, toddlers, boys and girls. We also offer accessories, which includes intimate apparel, handbags, hats, jewelry, footwear, toys, belts and sleepwear, as well as a limited assortment of home décor, which includes giftware, lamps, pictures, mirrors and figurines.

The following table sets forth our merchandise assortment by classification as a percentage of net sales for fiscal 2003.

Pricing.  We purchase our merchandise at low prices and mark prices up less than department or specialty stores. Our nationally recognized brands are offered at prices 20% to 60% below regular retail prices available in department stores and specialty stores, and that product offering validates both our value and fashion positioning to our consumers. We also consider the price-to-value relationships of our non-branded products to be strong. Our basic pricing strategy is everyday low prices. Our discount from the suggested retail price is usually reflected on the price tag. We review each department in our stores at least monthly for possible markdowns based on sales rates and fashion seasons to promote faster turnover of inventory and to accelerate the flow of current merchandise.

Sourcing and Allocation

Our merchandising department oversees the sourcing and allocation of merchandise to our stores, which allows us to utilize volume purchase discounts and maintain control over our inventory. We source our merchandise from over 1,000 vendors, consisting of domestic manufacturers and importers. For fiscal 2004, no vendor represented over 6% of our net sales. Our President and Chief Merchandising Officer supervises our 13 member planning and allocation team, as well as our buying team which is comprised of five merchandise managers and 14 buyers. Consistent with our plan to grow the intimate apparel and home décor categories, we recently added a dedicated buyer in home décor and upgraded our buying capabilities and focus in intimate apparel.

Our buyers have an average of 20 years of experience in the retail business and have developed long-standing relationships with many of our vendors, including those controlling the distribution of branded apparel. These buyers are responsible for maintaining vendor relationships, securing high quality, fashionable merchandise that meets our margin requirements and identifying and responding to emerging fashion trends. Our buyers, who are based in Savannah and New York, accomplish this by traveling to the major United States apparel markets regularly, visiting our major manufacturers and attending national and regional apparel trade shows, including urban-focused trade shows. We also retain the services of two independent fashion consulting firms that monitor market trends.

Our buyers purchase merchandise in styles, sizes and quantities to meet inventory levels developed by our planning staff. We work closely with our suppliers and are able to differentiate ourselves by our willingness to purchase less than a full assortment of styles, colors and sizes and by our policy of paying promptly and not asking for typical retail concessions such as promotional and markdown allowances. Our purchasing department utilizes several buying techniques that enable us to offer to consumers branded and other merchandise at everyday low prices. The majority of the nationally recognized branded products we sell are purchased in-season and represent our vendors’ excess inventories resulting from production or retailer order cancellations. We generally purchase later in the merchandising buying cycle than department and specialty stores. This allows us to take advantage of imbalances between retailers’ demands for specific merchandise and manufacturers’ supply of that merchandise. We also purchase merchandise from some vendors in advance of the selling season at reduced prices. Occasionally, we purchase merchandise on an opportunistic basis, which we then “pack and hold” for sale three to nine months later. Where possible, we seek to purchase items based on style or color in limited quantities on a test basis with the right to reorder as needed. Finally, we purchase private label merchandise that we source to our specifications.

As is customary in the industry, we do not enter into long-term contracts with any of our suppliers. While we believe we may encounter delays if we change suppliers, we believe alternate sources of merchandise for all product categories are available at comparable prices.

We allocate merchandise across our store base according to store-level demand. Our merchandising staff utilizes a centralized management system to monitor merchandise purchasing, allocation and sales in order to maximize inventory turnover, identify and respond to changing product demands and determine the timing of mark-downs to our merchandise. Our buyers also regularly review the age and condition of our merchandise and manage both the reordering and clearance processes. In addition, our merchandising team communicates with our regional, district and store managers to ascertain regional and store-level conditions and to better ensure that our product mix meets our consumers’ demands in terms of quality, fashion, price and availability.

Advertising and Marketing

Our advertising goal is to build the “Citi Trends” brand and promote consumers’ association of our brand with value, quality, fashion and everyday low prices. We generally focus our advertising efforts during the Easter, back-to-school and Christmas seasons. This advertising consists of radio commercials on local hip-hop radio stations that highlight our brands, our value and our everyday low prices. We also do in-store advertising that includes window signs designated for special purposes, such as seasonal events and clearance periods, and taped audio advertisements co-mingled with our in-store music programs. Signs change in color, quantity and theme every three to six weeks. For store grand openings, we typically seek to create community awareness and consumer excitement through radio advertising preceding and during the grand opening and by creating an on-site

event with local radio personalities broadcasting from the new location. We also distribute promotional items such as gift certificates and shopping sprees in connection with our grand openings.

Our marketing efforts center on promoting our everyday low prices and on demonstrating the strong price-to-value relationship of our products to our consumers. We do not utilize promotional advertising. Our merchandise is priced so that our competition rarely has lower prices. In the limited situations where our competition offers the same merchandise at a lower price, we will match the price.

Distribution

All merchandise sold in our stores is shipped directly from our distribution centers in Savannah, Georgia. In November 2004, we opened our second distribution center located on Coleman Boulevard, approximately 10 miles from our primary distribution center, the Fahm Street facility. The Coleman facility is used to process all receipts, as well as to warehouse “pack and hold” merchandise and merchandise held for new store openings. After merchandise is received and quality control functions are performed, the merchandise is moved to the Fahm Street facility for processing and shipping to the stores.

All work necessary to prepare the merchandise to be sales-floor ready is performed in our distribution centers. Some of our merchandise comes from vendors pre-ticketed and pre-packed and can be shipped directly from the distribution centers to our stores without repacking. However, most merchandise has to be price ticketed and repacked in store shipping units before being shipped to the stores.

We generally ship merchandise from Savannah to stores daily, but approximately 40 of our smaller volume stores receive merchandise every other day. Savannah is centrally located to our store base, and most of our stores are within a two-day drive from our distribution centers. We use United Parcel Service, Inc. and FedEx Corporation to ship merchandise to our stores. Our distribution centers have a combined 240,000 square feet, including approximately 20,000 square feet of office space. We expect these facilities to support our distribution and office capacity needs for at least the next two years. We intend to use a portion of the net proceeds from this offering to acquire or construct and design a new distribution center in fiscal 2006.

Quality control reviews of every merchandise receipt are performed by a dedicated team at the Coleman facility. This team is also responsible for working with our vendors and manufacturers to ensure consistent and superior quality across our private label merchandise, which accounts for approximately 10% of our net sales. Nearly all of our merchandise is purchased from recognized domestic manufacturers and importers, which reduces our risk of inadvertently handling counterfeit items.

Information Technology and Systems

We have information systems in place to support each of our business functions. We purchased our enterprise software from Island Pacific, a primary software provider to the retail industry. Our computer platform is an IBM AS400. The Island Pacific software supports the following business functions: purchasing, purchase order management, price and markdown management, distribution, merchandise allocation, general ledger, accounts payable and sales audit.

The Island Pacific merchandise system captures and reports sales and inventory by item, by store and by day. This information allows our merchandising team to evaluate merchandise performance in considerable detail with high levels of precision. Over the last four years we have enhanced the Island Pacific software, particularly to enhance merchandise allocation and distribution functions. In 2004, we purchased and installed Buyers Toolbox software to aid our merchandise planning and allocation functions.

Our stores use point-of-sale software from DataVantage, a division of MICROS Systems, Inc., to run our store cash registers. The system uses bar code scanners at checkout to capture item sales. It also supports end-of-day processing and automatically transmits sales and transaction data to Savannah each night. Additionally, the software supports store time clock and payroll functions. To facilitate marking down and re-ticketing merchandise, employees in our stores use hand-held scanners that read the correct item price and prepare new price tickets for merchandise. Our DataVantage software also enables us to sort and review transaction data, generate exception and other database reporting to assist in loss prevention.

In 2005, we plan to complete installation of the latest upgrade to the DataVantage software. The new software will enable improved and less costly telecommunications between stores and our Fahm Street facility. The upgrade will also provide improved credit and debit card processing, gift card capability, store e-mail and more reliable data transmissions to our home office systems.

We believe that our information systems, with upgrades and updates over time, are adequate to support our operations for the foreseeable future. Additionally, we are upgrading our website to enable Internet sales of selected urban branded apparel provided by third parties. We will earn commissions on these sales.

Competition

The markets we serve are highly competitive. We compete against a diverse group of retailers including national off-price retailers, mass merchants, smaller specialty retailers and dollar stores. The off-price retail companies that we compete with include The TJX Companies, Burlington Coat Factory and Ross Stores. In particular, TJX’s A.J. Wright stores target moderate income consumers. Ross Stores, Inc. has recently launched a similar concept targeting lower income consumers, called dd’s DISCOUNTS. We believe our strategy of appealing to African-American consumers and offering urban apparel products allows us to compete successfully with these retailers. We also believe we offer a more inviting store format than the off-price retailers with carpeted floors and more prominently displayed brands. We also compete with a group of smaller specialty retailers that only sell women’s products, such as Rainbow, Dots, Fashion Cents, It’s Fashions and Simply Fashions. Our mass merchant competitors include Wal-Mart and Kmart. These chains do not focus on fashion apparel and, within their apparel offering, lack the urban focus that we believe differentiates our offering and appeals to our core customers. Similarly, while some of the dollar store chains offer apparel, they typically offer a more limited selection focused on basic apparel needs.

Intellectual Property

We regard our trademarks and service marks as having significant value and as being important to our marketing efforts. We have registered the “Citi Trends” trademark with the U.S. Patent and Trademark Office on the Principal Register as both a trademark for retail department store services and as a trademark for clothing. We have also registered the following trademarks with the U.S. Patent and Trademark Office on the Principal Register: “Citi Club,” “Citi Knights,” “Citi Nite,” “Citi Steps,” “Citi Trends Fashion for Less,” “Citi Women,” “CT Sport,” “Univer Soul” and “Vintage Harlem.” We also have applications pending with the U.S. Patent and Trademark Office on the Principal Register for the following trademarks: “Citi Express,” “Diva Blue,” “Lil Citi Man,” “Lil Ms Hollywood” and “Urban Sophistication.” Our policy is to pursue registration of our marks and to oppose vigorously infringement of our marks.

Properties

All our existing 200 stores, totaling approximately 2.1 million gross square feet, are leased under operating leases. Additionally, as of February 10, 2005, we have signed leases for eleven new stores to be opened during fiscal 2005 aggregating approximately 148,320 total gross square feet. Our typical store lease is for five years with an option to extend our lease term for an additional five-year period, and requires us to pay percentage rent and increases in specified site-related charges. Nearly all of our store leases provide us the right to cancel following an initial three-year period in the event the store does not meet pre-determined sales levels.

We own an approximately 170,000 square foot facility located on Fahm Street in Savannah, Georgia, that serves as our headquarters and one of our two distribution centers. This facility is financed under a mortgage with a remaining principal balance of $1.5 million that is due in July 2007. We intend to repay this mortgage with a portion of the proceeds from this offering. We currently lease the land and building for our other distribution center located on Coleman Boulevard. The lease for this distribution center expires in September 2006, with options to renew for up to three more years. In addition, we currently lease 1,200 square feet in New York City, which is used for buyer operations and meetings with vendors.